Wall Street’s Insider Trading Tricks Spread Across U.S.

“I don’t recall a time in history where this many U.S. attorney’s offices and the SEC have brought so many big insider cases in such a short period,” Daniel Hawke, director of the Securities and Exchange Commission’s Market Abuse Unit, said in an interview. “It shows there’s a high level of activity and energy and coordination.” Source: U.S. Securities and Exchange Commission

Dec. 21 (Bloomberg) -- Former Wells Fargo & Co. investment
banker John Femenia was charged in Charlotte, North Carolina,
last week with leading an $11 million insider trading ring that
paid kickbacks in cash and gold for tips on corporate mergers.

In Santa Ana, California, former Major League Baseball
player Doug DeCinces was charged last month with making $1.3
million on tips he got from an executive at a medical eye-products company. In Newark, New Jersey, U.S. prosecutors
charged executives at three health-care companies Nov. 19 with
trading on illegal information.

Insider trading has moved beyond its traditional confines
on Wall Street -- and the U.S. government has followed.
Investigators and self-regulatory bodies are working more
closely and adopting new tactics to detect the lawbreakers
wherever they trade.

“I don’t recall a time in history where this many U.S.
attorney’s offices and the SEC have brought so many big insider
cases in such a short period,” Daniel Hawke, director of the
Securities and Exchange Commission’s Market Abuse Unit, said in
an interview. “It shows there’s a high level of activity and
energy and coordination.”

The number of people sued by the SEC or charged with
insider trading by the Justice Department has more than doubled
since 2008, data compiled by Bloomberg shows. There were 56 in
2008, 96 in 2009, 67 in 2010, 104 in 2011 and 125 this year. Of
those, 22 percent were linked to trading involving health-care
stocks.

All Sorts

People in many professions and relationships betrayed
trusts to make a quick buck. Bankers, lawyers, accountants,
doctors, traders, analysts, hedge-fund managers, company chiefs,
pharmaceutical executives and movie producers got into the act,
as did lovers, neighbors, classmates and fraternity brothers.
Even families: The SEC sued Rex C. Steffes of Manhattan,
Illinois, his three sons, his brother, and his brother-in-law
over illegal trading.

Bharara’s prosecutors also charged Mathew Martoma, a former
SAC Capital Advisors LP fund manager, on Nov. 20 in what they
called the most lucrative insider-trading case ever. The SEC
sued as well, joining prosecutors in claiming Martoma used
leaked data on a clinical drug trial to help SAC net $276
million in illicit profit and avoided losses.

Martoma’s Lawyer

Defense lawyer Charles Stillman has said he expects his
client to be exonerated.

The case against Femenia was the first of its type in that
area’s history, as the Justice Department and SEC showed an
interest in regional banking centers like Charlotte, home of
Bank of America Corp., the second-biggest U.S. lender by
deposits. Prosecutors there brought the Femenia indictment after
working with SEC lawyers in Atlanta, who filed their own lawsuit
a week earlier.

“The Southern District of New York is insider-trading
Ground Zero,” said Anne M. Tompkins, the U.S. attorney for the
Western District of North Carolina. “But we have thought for a
long time that it happens all over the country, particularly
where there is an investment banker.”

Organized Crime

With help from the SEC, Bharara’s office and the Federal
Bureau of Investigation built the Rajaratnam case through
tactics traditionally used to combat organized crime, such as
court-authorized wiretaps of phones, informants and cooperating
witnesses. Jurors heard 45 of the 2,400 secretly taped
conversations made during the probe.

Insider trading has offered an opportunity for the SEC to
enhance its image. Enforcement division attorneys have worked to
overcome the stain of failing to detect Bernard Madoff’s Ponzi
scheme, the largest in history. After Madoff’s arrest in
December 2008, money manager Harry Markopolos said the SEC
failed to heed his repeated warnings about Madoff.

When Robert Khuzami took over as the SEC enforcement
director in March 2009, he sought to rebuild the division’s
credibility and ability to detect the next waves of fraud. In
early 2010, he assigned more than 20 percent of his division to
five specialized groups, including Hawke’s Market Abuse Unit.

Computer Tactics

Hawke, a 13-year agency veteran who runs the Philadelphia
office, had already begun to develop better computer technology
to detect suspicious traders. In February 2009, his office sued
former UBS AG banker Nicos Stephanou and six others in a ring
that made $11.6 million in illicit profit. Stephanou pleaded
guilty and cooperated with prosecutors.

Stephanou, he said, was in one of several organized rings
of financial professionals who systematically ferreted out and
traded on inside information. Such rings lack the comfort of
trusting leaks to relatives or old friends, so they often cover
their tracks through disposable mobile phones, coded e-mails,
middlemen and other deceptions, Hawke said.

The Stephanou case was a “direct result of innovative
investigative techniques that the SEC is using to identify
patterns of unlawful trading and suspicious relationships among
traders,” Hawke said in a statement at the time.

New Techniques

With the creation of the dedicated unit, Hawke began to
apply those new techniques more broadly. The agency is
developing sophisticated computer programs to review trading
records and identify relationships among traders and
institutions.

While traditional insider-trading probes may have focused
on, say, all the buyers of shares of a company purchased in the
days before a takeover announcement, the new approach examines
traders and the timing and volume of their buying and selling,
Hawke said. It also looks for similar trading activity by
investors, without being certain if they know each other, he
said.

The SEC can request so-called Electronic Blue Sheets to
examine U.S. equity order and trade information. The U.S.
securities market has 13 stock exchanges and 11 options bourses.

“When you start with the trader and ask what stocks are
common to the traders, you open up the potential for the number
of stocks that could be common between them,” Hawke said. “You
could detect patterns and relationships among people who appear
to be trading in concert. The trader-based approach relies on a
constant querying of that data.”

57 People

Hawke’s 57-person unit includes attorneys and supervisors,
as well as quantitative analysts and specialists in trading
strategy, securities operations, market structure and high-frequency trading. The unit seeks to focus on those cases that
are difficult to detect and need close coordination with the
criminal authorities, he said.

The Financial Industry Regulatory Authority, which oversees
4,500 brokers, and the Options Regulatory Surveillance
Authority, also conduct analyses of trading patterns and alert
the SEC and the Justice Department.

“Because of the increased diagnostic skills of our
colleagues at the SEC, we’re able to drill much deeper into
insider trading in ways that weren’t previously accessible to
us,” said Douglas Leff, assistant special agent in charge at
the FBI’s New York office.

The FBI also has hired its own analysts, forensic
accountants and others with Wall Street experience, Leff said.

“The insider traders evolve into more cutting-edge ways to
conceal their activities,” Leff said. “So we work more closely
than ever with our friends at the SEC and Finra.”

While the SEC had typically asked people why they made
certain trades, which locked them into an explanation, that
approach doesn’t work with rings, Hawke said.

“In many cases, we don’t call up people now and ask them
why they trade,” Hawke said. “The people who are being
arrested in many instances are learning about the investigation
for the first time on the day of their arrest.”

Hawke’s approach bore fruit last year in the investigation
of New York trader Garrett Bauer, who had long come under SEC
suspicion as the possible recipient of inside information. After
a 2007 investigation of Bauer, the agency continued to monitor
Bauer’s trades to try to establish his possible source.

Trader Focus

By 2009, the agency determined that Bauer often traded in
the same stocks as Kenneth Robinson, a mortgage broker and his
friend. After watching Robinson’s trades, the SEC came to
suspect that his source may have been at Wilson Sonsini Goodrich
& Rosati PC, a law firm involved in deals.

The SEC took their suspicions to the U.S. prosecutors in
New Jersey, who worked with the FBI to approach Robinson. He
agreed in March 2011 to cooperate. Robinson confessed that his
friend, Wilson Sonsini attorney Matthew Kluger, was the source.
Robinson said Kluger stole merger tips from four law firms where
he had worked over a 17-year span. Robinson passed the tips to
Bauer, who made trades and rewarded the other two with cash.

Robinson agreed to make secret recordings of Bauer and
Kluger, who incriminated themselves before their arrest in April
2011. Prosecutors later said the scheme netted $37 million in
illicit profit, with Bauer making the most by far.

All three men pleaded guilty. Kluger was sentenced to 12
years in prison, the longest ever in an insider trading case;
Bauer got nine years; and Robinson received 27 months.

Automated Analysis

“The automated trading analysis helped us to establish the
relationship and gave us the pattern evidence to take to the
criminal authorities to go to Robinson,” Hawke said.

Hawke’s office also filed a lawsuit over the novel insider
trading case of Timothy McGee, a financial adviser from Malvern,
Pennsylvania. McGee learned in 2008 from a friend who worked at
Philadelphia Consolidated Holding Corp., an insurer, that it
would be bought by Tokio Marine Holdings Inc., according to the
SEC.

The friend was a Philadelphia Consolidated executive who
met McGee through Alcoholics Anonymous. The men had known each
other for a decade, sharing personal and professional
confidences, according to the agency. The friend returned to AA
meetings in July 2008. He told McGee he was helping to negotiate
the sale and was under great pressure, the SEC said.

McGee, 48, then bought shares of Philadelphia Consolidated
and sold them after the July 23, 2008, announcement of the $4.7
billion acquisition. McGee made illicit profit of $292,128,
according to the SEC.

McGee Case

McGee, who was also charged criminally, was convicted Nov.
15 of securities fraud and perjury after a trial in
Philadelphia. Jurors rejected McGee’s argument that the friend
never disclosed any material nonpublic information to him, which
meant he couldn’t have engaged in insider trading.

His lawyers have asked the judge for a new trial.

“Prosecutors had to prove that they had a history of
sharing this particular type of business information, and the
testimony made clear that the friend had never shared
confidential business information with Mr. McGee in the past,”
said McGee attorney John J. Rice in an interview. “AA certainly
did not create any duty of confidentiality between the men.”

Femenia’s indictment in Charlotte accuses him of stealing
information from Wells Fargo about mergers and acquisitions,
which he sold to friends in exchange for kickbacks of cash and
gold bars. Eight others were indicted, including Shawn Hegedus
and his girlfriend, Danielle Laurenti. Both are considered
fugitives, according to prosecutors.

Other Defendants

The six other defendants -- Matthew Musante, Frank Burgess
Jr., Aaron Wens, Roger Williams, Kenneth Raby and James Hayes --
have agreed to plead guilty and cooperate with the government,
according to court records. Wens entered his guilty plea today.

Femenia, 31, appeared today in federal court in Charlotte,
where he pleaded not guilty. He remains free on bail. At the
hearing today, a judge ordered him to keep a written log of all
of his phone calls and all of the phones he is using.

His attorneys, Mark Jones and Scott Morvillo, declined to
comment.

“This was an insider trading phone tree to friends for the
purpose of everybody making some money and the banker getting
some kickbacks,” Tompkins, the top federal prosecutor in
Charlotte, said in an interview this week.

She said her office and the SEC may bring different cases
as well through a task force they’ve formed.

“If we can get on these cases, work them hard, and bring
them to conclusion quickly, it sends a strong a message, that
this activity’s not just happening in New York,” Tompkins said.
“The message that it sends to citizens and potential defendants
is that there are a large number of eyes upon them.”